January 16, 2008

Fried Tomato Grower, Part I: Personal Liability

Informalities in connection with loans often lead to costly results. In Jackson v. Luellen Farms, 2007 Ind. App. LEXIS 2754 (JacksonOpinion.pdf), the Indiana Court of Appeals discussed in its December 12, 2007 opinion how a thirty-year business relationship turned into $200,000 in losses for a supplier of raw tomatoes. This is the first of two posts that address the Jackson case and the efforts of a party owed money to collect an antecedent debt from an owner/operator of a corporation. Advanced planning and documentation sometimes may be inconvenient, expensive or awkward, but it almost always can help protect lenders against financial losses.

Context. The plaintiff was LFI, a grower and supplier of tomatoes. Defendant Jackson was the owner and operator of HPI, a corporation that purchased and canned tomatoes. HPI often would not pay LFI on delivery but would wait until the first of the year. In October, 1999, HPI owed LFI about $225,000 for tomatoes delivered in 1998 and 1999. LFI evidently became nervous about getting paid, so for the first time the parties executed a Note to memorialize the amount owed. HPI made some payments on the Note but ultimately went under, owing $2.5-$3.0 million dollars to various creditors. LFI sought recovery from Jackson individually, and Jackson asserted two defenses: (1) he was not personally liable on the Note because he signed in a representative capacity and (2) the Note failed for a lack of consideration. I discuss the first defense in this post.

Was the Note a negotiable instrument? A sub-issue was whether Indiana’s UCC, specifically I.C. § 26-1-3.1-402 dealing with negotiable instruments, applied. (Typically, the UCC applies because most promissory notes meet the requirements of a negotiable instrument.) If the UCC applied, the burden of proof was on Jackson to in essence prove a negative: that both parties did not intend for him to be personally liable under the Note. Was the document was in fact a “negotiable instrument” as defined in I.C. § 26-1-3.1-104? The Court of Appeals concluded it was not, essentially because it purported to incorporate by reference the terms of a separate contract. The Note not only referred to a non-existent mortgage but, more importantly, indicated that all agreements and covenants in that mortgage applied to the Note – a no-no under the UCC. So, Jackson was not held to the heavy burden “to show that both parties to the Note intended that Jackson not make himself liable.”

Contract law. The issue of personal liability thus turned on the common law of contracts, not the UCC. And, plaintiff LFI had the burden of proof. In this scenario, courts apply a set of rules of construction and interpretation to arrive at a decision as to what the parties intended in the written document. The Court weighed a plethora of details about the language in the Note and the circumstances leading up to its execution. For example, after his signature, Jackson did not have the word “President.” In the final analysis, the Court concluded that “based on the manner in which Jackson signed the Note and our consideration of the surrounding circumstances, we conclude that the Note evidences a promise on the part of Jackson to pay LFI the amount owed by [HPI].” So, despite winning on the UCC/burden of proof issue, Jackson still got beat on his first defense.

On the hook? The Court’s conclusion in Jackson is favorable to Indiana creditors, particularly in the rare scenario where a Note does not constitute a negotiable instrument under the UCC. Absent clear and unambiguous language and/or facts showing that the amount of money was owed solely by the corporate entity, owners purporting to sign in a representative capacity could be at risk. In part II of this post, however, I’ll explain why the Indiana Court of Appeals ultimately found the Note to be unenforceable as to Jackson. LFI won a battle, but lost the war.

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Fried Tomato Grower, Part I: Personal Liability

Informalities in connection with loans often lead to costly results. In Jackson v. Luellen Farms, 2007 Ind. App. LEXIS 2754 (JacksonOpinion.pdf), the Indiana Court of Appeals discussed in its December 12, 2007 opinion how a thirty-year business relationship turned into $200,000 in losses for a supplier of raw tomatoes. This is the first of two posts that address the Jackson case and the efforts of a party owed money to collect an antecedent debt from an owner/operator of a corporation. Advanced planning and documentation sometimes may be inconvenient, expensive or awkward, but it almost always can help protect lenders against financial losses.

Context. The plaintiff was LFI, a grower and supplier of tomatoes. Defendant Jackson was the owner and operator of HPI, a corporation that purchased and canned tomatoes. HPI often would not pay LFI on delivery but would wait until the first of the year. In October, 1999, HPI owed LFI about $225,000 for tomatoes delivered in 1998 and 1999. LFI evidently became nervous about getting paid, so for the first time the parties executed a Note to memorialize the amount owed. HPI made some payments on the Note but ultimately went under, owing $2.5-$3.0 million dollars to various creditors. LFI sought recovery from Jackson individually, and Jackson asserted two defenses: (1) he was not personally liable on the Note because he signed in a representative capacity and (2) the Note failed for a lack of consideration. I discuss the first defense in this post.

Was the Note a negotiable instrument? A sub-issue was whether Indiana’s UCC, specifically I.C. § 26-1-3.1-402 dealing with negotiable instruments, applied. (Typically, the UCC applies because most promissory notes meet the requirements of a negotiable instrument.) If the UCC applied, the burden of proof was on Jackson to in essence prove a negative: that both parties did not intend for him to be personally liable under the Note. Was the document was in fact a “negotiable instrument” as defined in I.C. § 26-1-3.1-104? The Court of Appeals concluded it was not, essentially because it purported to incorporate by reference the terms of a separate contract. The Note not only referred to a non-existent mortgage but, more importantly, indicated that all agreements and covenants in that mortgage applied to the Note – a no-no under the UCC. So, Jackson was not held to the heavy burden “to show that both parties to the Note intended that Jackson not make himself liable.”

Contract law. The issue of personal liability thus turned on the common law of contracts, not the UCC. And, plaintiff LFI had the burden of proof. In this scenario, courts apply a set of rules of construction and interpretation to arrive at a decision as to what the parties intended in the written document. The Court weighed a plethora of details about the language in the Note and the circumstances leading up to its execution. For example, after his signature, Jackson did not have the word “President.” In the final analysis, the Court concluded that “based on the manner in which Jackson signed the Note and our consideration of the surrounding circumstances, we conclude that the Note evidences a promise on the part of Jackson to pay LFI the amount owed by [HPI].” So, despite winning on the UCC/burden of proof issue, Jackson still got beat on his first defense.

On the hook? The Court’s conclusion in Jackson is favorable to Indiana creditors, particularly in the rare scenario where a Note does not constitute a negotiable instrument under the UCC. Absent clear and unambiguous language and/or facts showing that the amount of money was owed solely by the corporate entity, owners purporting to sign in a representative capacity could be at risk. In part II of this post, however, I’ll explain why the Indiana Court of Appeals ultimately found the Note to be unenforceable as to Jackson. LFI won a battle, but lost the war.